<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ..... to .....
Commission File Number 1-5263
THE LUBRIZOL CORPORATION
(Exact name of registrant as specified in its charter)
Ohio 34-0367600
(State or other jurisdiction of (I.R.S.Employer
incorporation or organization) Identification No.)
29400 Lakeland Boulevard
Wickliffe, Ohio 44092-2298
(Address of principal executive offices)
(Zip Code)
(440) 943-4200
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ X ] No [ ]
Number of the registrant's common shares, without par value, outstanding, as of
July 30, 1999: 54,605,352
<PAGE> 2
PART I. FINANCIAL INFORMATION
-----------------------------
Item 1 Financial Statements
---------------------------
THE LUBRIZOL CORPORATION
------------------------
<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEETS
- -------------------------------------------------------------------------------------
June 30 December 31
(In Thousands of Dollars) 1999 1998
- -------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
- ------
Cash and short-term investments. . . . . . . . . . . . $ 124,866 $ 53,639
Receivables. . . . . . . . . . . . . . . . . . . . . . 313,594 301,644
Inventories:
Finished products. . . . . . . . . . . . . . . . . . 111,006 112,060
Products in process. . . . . . . . . . . . . . . . . 58,169 66,485
Raw materials. . . . . . . . . . . . . . . . . . . . 65,548 80,134
Supplies and engine test parts . . . . . . . . . . . 17,365 18,933
------ ------
252,088 277,612
------- -------
Other current assets . . . . . . . . . . . . . . . . . 31,828 54,575
------ ------
Total current assets . . . . . . . 722,376 687,470
Property and equipment - net . . . . . . . . . . . . . 692,772 718,850
Goodwill and intangible assets - net . . . . . . . . . 157,620 166,957
Investments in nonconsolidated companies . . . . . . . 29,593 26,490
Other assets . . . . . . . . . . . . . . . . . . . . . 39,933 43,470
------ ------
TOTAL . . . . . . . . . . . . $1,642,294 $1,643,237
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Short-term debt and current portion of long-term debt $ 15,663 $ 38,926
Accounts payable . . . . . . . . . . . . . . . . . . . 119,060 112,832
Accrued expenses and other current liabilities . . . . 126,875 118,270
------- -------
Total current liabilities. . . . . 261,598 270,028
Long-term debt . . . . . . . . . . . . . . . . . . . . 390,032 390,394
Postretirement health care obligation. . . . . . . . . 107,105 106,641
Noncurrent liabilities . . . . . . . . . . . . . . . . 44,159 48,950
Deferred income taxes. . . . . . . . . . . . . . . . . 57,172 58,106
------ ------
Total liabilities. . . . . . . . . 860,066 874,119
------- -------
</TABLE>
<TABLE>
<CAPTION>
Contingencies and commitments
Shareholders' equity:
Preferred stock without par value - authorized
and unissued:
Serial Preferred Stock - 2,000,000 shares
Serial Preference Shares - 25,000,000 shares
Common Shares without par value:
Authorized 120,000,000 shares
Outstanding - 54,602,756 shares as of June 30,
1999 after deducting 31,593,138 treasury
shares, 54,548,110 shares as of December 31,
<S> <C> <C>
1998 after deducting 31,647,784 treasury shares 85,924 84,651
Retained earnings. . . . . . . . . . . . . . . . . . 750,749 709,994
Accumulated other comprehensive income (loss). . . . (54,445) (25,527)
-------- --------
Total shareholders' equity . . . . 782,228 769,118
------- -------
TOTAL . . . . . . . . . . . . $1,642,294 $1,643,237
========== ==========
</TABLE>
Amounts shown are unaudited.
-2-
<PAGE> 3
THE LUBRIZOL CORPORATION
------------------------
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF INCOME
- ------------------------------------------------------------------------------------------------------
Second Quarter Six Months
Ended June 30 Ended June 30
---------------------------------------------------------------
In Thousand Except Per Share Data) 1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net sales. . . . . . . . . . . . . . $433,129 $405,160 $879,756 $805,060
Royalties and other revenues . . . . 1,056 807 1,974 1,272
------- ------- ------- -------
Total revenues . . . . . . 434,185 405,967 881,730 806,332
Cost of sales. . . . . . . . . . . . 296,985 279,017 600,159 556,052
Selling and administrative expenses 47,519 42,992 92,522 85,020
Research, testing and development
expenses . . . . . . . . . . . . . 35,600 35,092 72,498 70,372
------- ------- ------- -------
Total cost and expenses. . 380,104 357,101 765,179 711,444
Gain from litigation settlement. . . 16,201 14,476 16,201
Special charge . . . . . . . . . . . (3,136)
Other income (expense) - net . . . . (160) 638 (3,268) 1,663
Interest income. . . . . . . . . . . 1,795 1,411 2,802 2,731
Interest expense . . . . . . . . . . (7,284) (3,865) (14,424) (6,938)
------- ------- ------- -------
Income before income taxes . . . . . 48,432 63,251 113,001 108,545
Provision for income taxes . . . . . 18,404 23,288 43,879 38,914
------- ------- ------- -------
Net income . . . . . . . . . . . . . $ 30,028 $ 39,963 $ 69,122 $ 69,631
======= ======= ======= =======
Net income per share . . . . . . . . $0.55 $0.71 $1.27 $1.23
======= ======= ======= =======
Net income per share, diluted. . . . $0.55 $0.71 $1.26 $1.22
======= ======= ======= =======
Dividends per share. . . . . . . . . $0.26 $0.26 $0.52 $0.52
======= ======= ======= =======
Average common shares outstanding. . 54,564 56,331 54,556 56,584
</TABLE>
Amounts shown are unaudited.
-3-
<PAGE> 4
THE LUBRIZOL CORPORATION
------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
Six Months Ended
June 30
---------------------------------
(In Thousands of Dollars) 1999 1998
- --------------------------------------------------------------------------------------
Cash provided from (used for):
Operating activities:
<S> <C> <C>
Net income. . . . . . . . . . . . . . . . . . . . . $ 69,122 $ 69,631
Adjustments to reconcile net income to cash provided
by operating activities:
Depreciation and amortization . . . . . . . . . 48,245 42,825
Deferred income taxes . . . . . . . . . . . . . 1,994 3,314
Special charge. . . . . . . . . . . . . . . . . 3,136
Change in current assets and liabilities:
Receivables . . . . . . . . . . . . . . . . . (24,434) (16,970)
Inventories . . . . . . . . . . . . . . . . . 17,123 (13,130)
Accounts payable and accrued expenses . . . . 21,757 (6,039)
Other current assets. . . . . . . . . . . . . 20,995 2,516
Other items - net . . . . . . . . . . . . . . . (1,380) 78
------ ------
Total operating activities. . . . . . . . 156,558 82,225
Investing activities:
Capital expenditures. . . . . . . . . . . . . . . (34,034) (47,641)
Acquisitions and investments in nonconsolidated
companies . . . . . . . . . . . . . . . . . . . (14,630)
Other - net . . . . . . . . . . . . . . . . . . . 675 462
------ ------
Total investing activities. . . . . . . . (33,359) (61,809)
Financing activities:
Short-term borrowing (repayment). . . . . . . . . (22,587) 22,292
Long-term borrowing . . . . . . . . . . . . . . . 5,000
Long-term repayments. . . . . . . . . . . . . . . (2,640) (1,906)
Dividends paid. . . . . . . . . . . . . . . . . . (28,367) (29,432)
Common shares (purchased) net of options exercised 1,273 (38,981)
------ ------
Total financing activities. . . . . . . . (47,321) (48,027)
Effect of exchange rate changes on cash . . . . . . (4,651) (995)
------ ------
Net increase (decrease) in cash and short-term
investments . . . . . . . . . . . . . . . . . . . 71,227 (28,606)
Cash and short-term investments at the beginning
of period . . . . . . . . . . . . . . . . . . . . 53,639 86,504
------ ------
Cash and short-term investments at end of period. . $124,866 $ 57,898
======= ======
</TABLE>
-4-
Amounts shown are unaudited.
<PAGE> 5
THE LUBRIZOL CORPORATION
------------------------
Notes to Consolidated Financial Statements
------------------------------------------
June 30, 1999
1. The accompanying unaudited consolidated financial statements contain all
adjustments (consisting only of normal recurring accruals) necessary to
present fairly the financial position as of June 30, 1999 and December 31,
1998, and the results of operations and cash flows for the applicable
periods ended June 30, 1999 and 1998.
2. Net income per share is computed by dividing net income by average common
shares outstanding during the period. Net income per share, diluted,
includes the dilution effect resulting from outstanding stock options and
stock awards.
Per share amounts are computed as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30 June 30
----------------------- -----------------------
1999 1998 1999 1998
---- ---- ---- ----
Numerator:
<S> <C> <C> <C> <C>
Net income available to
common shares $30,028 $39,963 $69,122 $69,631
======= ======= ======= =======
Denominator:
Weighted average common
shares outstanding 54,564 56,331 54,556 56,584
Dilutive effect of stock
options and awards 167 275 113 295
------- ------- ------- -------
Denominator for net income
per share, diluted 54,731 56,606 54,669 56,879
======= ======= ======= =======
Net income per share $ .55 $ .71 $ 1.27 $ 1.23
======= ======= ======= =======
Net income per share,
diluted $ .55 $ .71 $ 1.26 $ 1.22
======= ======= ======= =======
</TABLE>
3. Total comprehensive income for the three- and six-month periods ended June
30, 1999 and 1998 is comprised as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30 June 30
------------------------- -------------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income $ 30,028 $ 39,963 $ 69,122 $ 69,631
Other comprehensive
(loss) (8,751) (3,565) (28,918) (3,499)
-------- -------- -------- --------
Total comprehensive
income $ 21,277 $ 36,398 $ 40,204 $ 66,132
======== ======== ======== ========
</TABLE>
Other comprehensive (loss) in each of the periods above is solely comprised of
foreign currency translation adjustments, net of related tax effects.
-5-
<PAGE> 6
THE LUBRIZOL CORPORATION
------------------------
Notes to Consolidated Financial Statements
------------------------------------------
June 30, 1999
4. The company recorded a special charge of $23.3 million in the fourth
quarter of 1998 related to the first phase of its cost reduction program.
In the first quarter of 1999, the company recognized additional expense of
$3.1 million, to reflect a greater amount for separation benefits,
principally in Japan. This first phase resulted in a reduction of
approximately 300 employees, most of whom were entitled to special
severance benefit payments with the remaining positions eliminated through
attrition. Substantially all the affected employees had terminated
employment as of June 30, 1999. The special charge also included $2.8
million for the impairment of assets related to production units to be
taken out of service. These units were permanently removed from service
during the first quarter of 1999. Cash expenditures related to the cost
reduction program of approximately $5.0 million and $16.3 million were made
in the fourth quarter of 1998 and first half of 1999, respectively.
Approximately $2.3 million remains as an accrued liability at June 30,
1999, representing cash relating to severance and other payments yet to be
made in 1999.
On July 29, 1999, the company announced the beginning of the second phase
of its cost reduction program, focusing on lowering costs and improving
efficiency in production and distribution activities. As part of this plan,
the company's Painesville, Ohio, manufacturing plant will be reduced in
size from 36 to 13 production systems between the third quarter of 1999 and
the latter part of 2000, with most of this production to be transferred to
the company's Deer Park, Texas, facility. Staff reductions of approximately
200 employees at Painesville will occur by the end of 2000, largely through
voluntary separations and early retirements. The company currently expects
to record a special charge of approximately $30 million in the third
quarter to cover the costs of asset write-downs and severance and other
expenses. Nearly half of the anticipated charge is expected to represent
cash expenditures to be made for employee severance payments and other exit
costs, and the remainder is expected to represent non-cash asset impairment
losses. In order to achieve operational savings, the company will spend
approximately $9 million of capital in the U.S. to replace existing
Painesville capacity. Savings from the Painesville plant reductions are
estimated to be $21 million per year by the latter part of 2000. After
restructuring, the Painesville plant will continue to operate as a producer
of smaller volume specialized intermediates and blender of certain additive
packages.
5. The company has filed claims against Exxon Corporation and/or its
affiliates relating to various commercial matters, including alleged
infringements by Exxon of certain of the company's patents.
On March 31, 1999, the company and Exxon Corporation reached a settlement
of all pending intellectual property litigation between the two companies
and their affiliates, except for litigation pending in Canada. Under the
settlement agreement, Exxon paid the company cash of $16.8 million in April
1999. After deducting related expenses, this settlement increased pre-tax
income by $14.5 million for the three-month period ended March 31, 1999 and
the six months ended June 30, 1999.
-6-
<PAGE> 7
THE LUBRIZOL CORPORATION
------------------------
Notes to Consolidated Financial Statements
------------------------------------------
June 30, 1999
The company has prevailed in a case brought in Canada against Exxon's
Canadian affiliate, Imperial Oil, Ltd., for infringement of the company's
patent pertaining to dispersants, the largest additive component used in
motor oils. A 1990 trial court verdict in favor of the company regarding
the issue of liability was upheld by the Federal Court of Appeals of Canada
in December 1992, and in October 1993, the Supreme Court of Canada
dismissed Imperial Oil's appeal of the Court of Appeals' decision. The case
has been returned to the trial court for an assessment of compensation
damages, but no date has been set for a determination of such damages. In
October 1994, the trial court judge determined that Imperial Oil had
violated an earlier injunction for the manufacture or sale of the
dispersant that is the subject of this case. The determination of penalty
damages, if any, on account of this violation will be made after the court
has determined the compensation damages for patent infringement. A
reasonable estimation of the company's potential recovery relating to this
litigation can not be made at this time, and no amounts that may be
recovered in the future have been recorded in the company's financial
statements as of June 30, 1999.
On April 23, 1998, the company reached a settlement with Exxon of a lawsuit
pending in federal court in Ohio and received cash of $19 million. After
deducting related expenses, this settlement increased pre tax income by
$16.2 million for the three- and six-month periods ended June 30, 1998.
6. At December 31, 1998, the company adopted Statement of Financial Standards
(SFAS) 131, "Disclosures about Segments of an Enterprise and Related
Information". This statement establishes standards for reporting
information about operating segments and related disclosures about products
and services, geographic areas and major customers. The company aggregates
its product lines into two principal operating segments: chemicals for
transportation and chemicals for industry. The company evaluates
performance and allocates resources based on segment contribution income,
defined as revenues less expenses directly identifiable to the product
lines aggregated within each segment. In addition, the company allocates
corporate research, testing, selling and administrative expenses in
arriving at segment operating profit before tax.
-7-
<PAGE> 8
THE LUBRIZOL CORPORATION
------------------------
Notes to Consolidated Financial Statements
------------------------------------------
June 30, 1999
The following table presents a summary of the company's reportable segments
for the three- and six months ended June 30, 1999 and 1998 on a basis of
segmentation and on a basis of measurement of segment contribution income
consistent with the previous year end:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30 June 30
--------------------------- ---------------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue from external customers:
Chemicals for transportation $ 361,712 $ 344,877 $ 735,884 $ 686,759
Chemicals for industry 72,473 61,090 145,846 119,573
--------- --------- --------- ---------
Total revenues $ 434,185 $ 405,967 $ 881,730 $ 806,332
========= ========= ========= =========
Segment contribution income:
Chemicals for transportation $ 78,642 $ 71,319 $ 158,415 $ 138,967
Chemicals for industry 9,308 9,164 20,377 17,769
--------- --------- --------- ---------
Total segment contribution
income $ 87,950 $ 80,483 $ 178,792 $ 156,736
========= ========= ========= =========
Segment operating profit before tax:
Chemicals for transportation $ 48,317 $ 43,290 $ 100,018 $ 84,529
Chemicals for industry 5,604 6,214 13,265 12,022
--------- --------- --------- ---------
Total segment operating
profit before tax 53,921 49,504 113,283 96,551
Gain from litigation settlement 16,201 14,476 16,201
Special charge (3,136)
Interest expense - net (5,489) (2,454) (11,622) (4,207)
--------- --------- --------- ---------
Consolidated income before tax $ 48,432 $ 63,251 $ 113,001 $ 108,545
========= ========= ========= =========
</TABLE>
7. In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS
133, Accounting for Derivative Instruments and Hedging Activities, which
was to become effective for the company no later than January 1, 2000. In
June 1999, the FASB issued a further pronouncement which delayed the
effective date for the company to January 1, 2001. SFAS 133 establishes
accounting and reporting standards for derivative instruments and for
hedging activities. It requires that all derivatives be measured at fair
value and recognized as either assets or liabilities in the balance sheet.
The accounting for changes in the fair value of a derivative (that is,
gains or losses) depends on the intended use of the derivative and its
resulting hedge designation. The company uses derivative financial
instruments only to manage well-defined foreign currency and interest rate
risks. The company does not use derivative financial interests for trading
purposes. The company is currently evaluating the requirements and effects
of SFAS 133, but has not yet determined the impact on its financial
position and results of operations when adopted.
-8-
<PAGE> 9
THE LUBRIZOL CORPORATION
------------------------
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations
---------------------------------------------
RESULTS OF OPERATIONS
- ---------------------
Consolidated revenues increased 7% in the second quarter and 9% for the six
months compared with 1998, primarily as a result of acquisitions and higher
lubricant additive shipment levels in North America and Asia Pacific. Lower
average selling prices were tempered by lower raw material costs and stable
plant manufacturing expenses, resulting in a higher gross profit percent for the
first half as compared to 1998. Selling, administrative and technical expenses
increased, mostly because of acquisitions. After excluding litigation settlement
gains and an adjustment to a special charge, net income increased 2% for the
second quarter and 7% for the first half as compared to 1998. On a similar
basis, net income per share increased 6% for the 1999 second quarter and 12% for
the 1999 six-month period. Detailed comments relating to the company's results
of operations and financial position follow below.
The company groups its product lines into two operating segments: chemicals for
transportation and chemicals for industry. Chemicals for transportation
comprises the predominant portion of the company's consolidated revenues and
segment pretax operating profits. This discussion and analysis of the company's
financial condition and results of operations is primarily focused upon the
company as a whole, rather than the individual operating segments, since the
company believes this provides the most appropriate understanding of its
business. See Note 6 to the financial statements for further financial
disclosures by operating segment.
Consolidated revenues increased $28.2 million or 7% for the second quarter of
1999 compared with the second quarter of 1998 and increased $75.4 million or 9%
for the first half of 1999 compared with the first half of 1998. On a
year-to-year comparative basis, chemicals for transportation revenues increased
$16.8 million, or 5%, for the second quarter and $49.1 million, or 7%, for the
six months. On a similar basis, chemicals for industry revenues increased $11.4
million, or 19%, for the second quarter and $26.3 million, or 22%, for the six
months. Acquisitions accounted for all of the consolidated revenue increase in
the second quarter and $60.3 million, or seven percentage points, of the first
half increase. Excluding acquisitions, second quarter volume increased 2%
compared with the same period in 1998.
Sales volume increased 9% in the second quarter (2% excluding acquisitions) and
11% in the first half (4% excluding acquisitions) compared with 1998. North
American shipments increased 10% for the quarter and 14% for the six months,
with only 1% of the increase in each period attributable to acquisitions, as the
region's results benefited from new business awarded in the second half of 1998
and some spot business. Shipments to international customers increased 8% for
the quarter and 9% for the six months compared with 1998, principally because of
acquisitions. Excluding acquisitions, international volume for the quarter was
down 4% and volume for the six months increased 3%. Year to date shipments in
Asia Pacific, excluding acquisitions, increased 15% compared to 1998 due partly
to the order pattern of a particular customer, but also to economic improvement
in the region. Year to date volume in Europe and Latin America, excluding
acquisitions, decreased 11% and 8%, respectively, due primarily to sluggish
economies, with some business loss. The company believes its current market
share, on a worldwide basis, is approximately the same as the combined Lubrizol
and Adibis market shares of a year ago.
-9-
<PAGE> 10
THE LUBRIZOL CORPORATION
------------------------
Management's Discussion and Analysis of
Financial Condition and Results of Operations
---------------------------------------------
Average additive selling price for both the second quarter and the first six
months of 1999 declined 4% compared with 1998, caused primarily by weaker
product mix and lower pricing, and to a lesser extent by unfavorable currency.
Sequentially, average selling price declined 3% from the first quarter to the
second quarter of 1999 because of the same factors.
Cost of sales for the three and six-month periods ended June 30, 1999 increased
6% and 8%, respectively, reflecting the increase in shipment levels between the
periods partially offset by a reduction in average raw material costs. Plant
manufacturing expenses, excluding acquisitions, were flat. The company
anticipates upward pressure on raw material costs in the second half of 1999 as
a result of higher crude oil pricing and its downstream effect.
Gross profit (sales less cost of sales) increased $10.0 million or 8% for the
second quarter of 1999, and $30.6 million or 12% for the first half of 1999,
compared with the same periods in 1998. Approximately half of the increase in
the second quarter and 40% of the first half increase was due to acquisitions,
and approximately 20% in each period was due to currency effects. The remaining
increase was due to higher volume and lower raw material costs, offset by lower
average selling prices. These factors caused the gross profit percentage (net
sales divided by cost of sales) to be 31.4% in the second quarter of 1999 and
31.8% in the first half, compared with 31.1% and 30.9% in the respective periods
of 1998.
Selling and administrative expenses increased 11% (5% excluding acquisitions)
for the second quarter of 1999 compared with 1998, and increased 9% (3%
excluding acquisitions) for the first half of 1999 compared with 1998. The
increases were primarily due to the accrual of higher variable performance pay
based on 1999 results, and system-related expenses in connection with the
implementation of the new enterprise-wide management information system and
year-2000 compliance efforts.
Research, testing and development expenses (technology expenses) increased 1%
for the second quarter and 3% for the first six months of 1999 compared with the
same periods of 1998. Excluding acquisitions, technology expenses decreased 2%
in the second quarter and were flat with 1998 for the six months. The first
quarter of 1999 had included higher spending for engine tests conducted at third
party facilities to meet performance specifications; such spending was reduced
in the second quarter as products were qualified. The company anticipates a
delay in the effective date of the U.S. passenger car motor oil technical
standard, GF-3, and hence a delay in the related testing activities. The company
expects this will enable it to reduce 1999 full-year technology expenses to an
amount below the 1998 level. The company intends to carefully manage the impact
of the delay on year 2000 testing expenses.
-10-
<PAGE> 11
THE LUBRIZOL CORPORATION
------------------------
Management's Discussion and Analysis of
Financial Condition and Results of Operations
---------------------------------------------
Primarily as a result of the above factors, 1999 second quarter revenues
increased by $5.2 million more than the increase in total cost and expenses, and
1999 first half revenues increased $21.7 more than the increase in total cost
and expenses, in each case as compared to 1998.
The change in other income negatively affected pre-tax income by $.8 million for
the second quarter and by $4.9 million for the first half of 1999 compared with
1998. The unfavorable change for the six months was due primarily to higher
amortization of goodwill relating to acquisitions made in the second half of
1998 and higher currency translation and transaction losses, principally in
Brazil, which was partially offset by higher equity earnings of affiliated
companies.
Interest expense (net of interest income) increased $3.0 million for the second
quarter and $7.4 million for the first half of 1999 principally because of
higher borrowings necessitated by the acquisitions made during the second half
of 1998.
On March 31, 1999, the company and Exxon Corporation reached a settlement of all
pending intellectual property litigation between the two companies and their
affiliates, except for litigation pending in Canada. Under the settlement
agreement, Exxon paid the company cash of $16.8 million in April 1999. After
deducting related expenses, this settlement increased pre-tax income by $14.5
million ($9.0 million after-tax or $.16 per share) for the three months ended
March 31, 1999, and the six months ended June 30, 1999. Refer to Note 5 to the
financial statements for further discussion regarding the company's litigation
with Exxon.
In the first quarter of 1999, the company recognized additional expense of $3.1
million ($2.9 million after-tax or $.05 per share), to reflect an additional
amount for separation benefits, principally in Japan, under its cost reduction
program originally announced and recognized in the fourth quarter of 1998. For
further information, see the caption "Cost Reduction Program" below and Note 4
to the financial statements.
During 1998, the company increased its annual effective tax rate (ETR) once in
the second quarter and again in the third quarter in arriving at an annual ETR
of 38%, on pre-tax income before the gain from a litigation settlement and a
special charge. In the first half of 1999, the ETR, before the gain from another
litigation settlement and the increase to the special charge, was 38% as
compared to 36% for the first half of 1998. The higher ETR had an unfavorable
effect of $.04 on earnings per share for the first half of 1999, but no impact
on earnings per share for the second quarter of 1999. After considering the tax
effects of the gains from the litigation settlements and the special charge, the
ETR was 38.8% for the first half of 1999 compared with 35.9% for the first half
of 1998.
-11-
<PAGE> 12
THE LUBRIZOL CORPORATION
------------------------
Management's Discussion and Analysis of
Financial Condition and Results of Operations
---------------------------------------------
Primarily as a result of the above factors, net income for the second quarter of
1999 was $30.0 million or $.55 per share as compared to $40.0 million or $.71
per share for the second quarter of 1998. For the first half of 1999, net income
was $69.1 million or $1.27 per share ($1.26 per share diluted) as compared to
$69.6 million or $1.23 per share for the first half of 1998. After excluding
from 1999 the first quarter gain from the litigation settlement and the
adjustment to the special charge, and after excluding from 1998 the second
quarter litigation settlement, net income in the second quarter of 1999 was
$30.0 million ($.55 per share) compared to $29.4 million ($.52 per share) in the
second quarter of 1998; and net income for the six months of 1999 was $63.0
million ($1.16 per share; $1.15 per share diluted) compared to $59.1 million
($1.04 per share) for the first half of 1998.
WORKING CAPITAL, LIQUIDITY AND CAPITAL RESOURCES
- ------------------------------------------------
Cash provided from operating activities was $156.6 million for the first six
months of 1999 compared with $82.2 million for the first six months of 1998. The
improvement in cash flow from operations was principally attributable to a $35
million reduction in working capital in 1999 compared to $34 million growth in
working capital in 1998. The company put initiatives in place in 1999 to reduce
investment in inventories and receivables.
Capital expenditures in the first half of 1999 were $34.0 million compared with
$47.6 million for same 1998 period. The reduction was due to lower spending on
manufacturing projects and reduced spending on the enterprise-wide management
information system. The company estimates capital spending for the full year
1999 will be approximately $80 million, compared with $93.4 million in 1998.
The company expended $14.6 million in cash for two acquisitions made during the
first quarter of 1998. The acquisitions were in the company's chemicals for
industry operating segment, in the business areas of metalworking additives and
coating additives.
In prior years the company maintained an active share repurchase program.
However, the company did not repurchase any shares during the first half of 1999
and does not anticipate making share repurchases during the remainder of 1999.
The increase in cash flow from operating activities, and the absence of share
repurchases, enabled the company to reduce its borrowings by $20.2 million
during the six months ended June 30, 1999. The company's net debt as a percent
of total capitalization (shareholders' equity plus net short- and long-term
debt) decreased from 35% at December 31, 1998 to 29% at June 30, 1999 because of
the strong cash flow. Net debt is the total of short- and long-term debt,
reduced by cash and short-term investments in excess of an assumed operating
cash level of $40 million.
Primarily as a result of these activities and the payment of dividends, the
balance of cash and short-term investments increased $71.2 million at June 30,
1999 compared with December 31, 1998.
-12-
<PAGE> 13
THE LUBRIZOL CORPORATION
------------------------
Management's Discussion and Analysis of
Financial Condition and Results of Operations
---------------------------------------------
The company's financial position remains strong with a ratio of current assets
to current liabilities of 2.8 to 1 at June 30, 1999 compared with a ratio of 2.5
to 1 at December 31, 1998. The company had $300 million in available committed
revolving credit facilities at December 31, 1998, of which half expired on June
30, 1999. The other half, which remains unused, expires June 30, 2003. The
company did not renew the $150 million in facilities which expired because the
November 1998 issuance of $200 million in long-term notes reduced the expected
financial requirements. The company believes its current credit facilities,
internally generated funds and ability to obtain additional financing will be
sufficient to meet its future spending needs.
COST REDUCTION PROGRAM
- ----------------------
The company initiated a series of steps in 1998 to reduce costs and improve its
worldwide operating structure and is executing these steps in two phases over a
period approximating two years. The first phase, which began in the fourth
quarter of 1998, has resulted in employee reductions of approximately 7%, or 300
employees at both domestic and international locations. Approximately 55% of the
employee reductions occurred by December 31, 1998, a further 35% occurred in the
first quarter of 1999, and the remainder has substantially been completed in the
second quarter of 1999.
The company estimates these actions will lower future operating costs by an
annualized amount of $28 million beginning in 1999, of which approximately $11
million has been realized through June 30, 1999. Refer to Note 4 to the
financial statements for further information regarding the cost reduction
program.
Cash expenditures related to the cost reduction program of approximately $5.0
million and $16.3 million were made in the fourth quarter of 1998 and first half
of 1999, respectively. Approximately $2.3 million remains as an accrued
liability at June 30, 1999, representing cash yet to be paid in 1999.
The second phase of the company's cost reduction program, announced July 29,
1999, will focus on lowering costs and improving efficiency in production and
distribution activities. See Note 4 to the financial statements for further
discussion.
YEAR 2000 MATTERS
- -----------------
THIS IS A YEAR 2000 READINESS DISCLOSURE UNDER THE YEAR 2000 INFORMATION
AND READINESS DISCLOSURE ACT, P.L. 105-271
The company relies on its computer-based management information systems, as well
as computer-based systems used for other purposes, in conducting its normal
business activities. Certain of these computer-based programs may not have been
designed to function properly with respect to the application of dating systems
relating to the Year 2000 and beyond.
-13-
<PAGE> 14
THE LUBRIZOL CORPORATION
------------------------
Management's Discussion and Analysis of
Financial Condition and Results of Operations
---------------------------------------------
The company has developed a global Year 2000 strategy covering each of its
facilities designed to minimize Year 2000 disruptions to its computer-based
systems, including business information systems and process control, testing and
laboratory equipment and embedded systems. The Year 2000 project manager
regularly updates the company's senior management as to the implementation
status of the Year 2000 strategy, and periodic reviews are conducted with the
company's Audit Committee and Board of Directors. The company believes that its
computer-based systems will be functional and operate without significant
disruption both before and after January 1, 2000.
The company's Year 2000 compliance strategy incorporates the conversion of most
of its business information systems from mainframe systems to compliant,
client/server systems. The company believes that implementation of such systems
has permitted it to avoid approximately 80% of the effort that otherwise would
have been required to make these legacy systems Year 2000 compliant. This
conversion process is part of the company's global enterprise-wide management
information system, which was implemented in the United States during 1998 and
implemented in Europe in April 1999. Although the implementation date for the
global enterprise-wide management system at a number of company facilities
outside of the United States and Europe is anticipated to be after January 1,
2000, the company has developed Year 2000 compliance plans to address business
information systems at each of those facilities.
The company estimates approximately 20% of the total remediation effort is
attributable to activities not related to the global enterprise-wide management
information system discussed above. Based upon the effort expended through July
31, 1999, the company believes it has completed approximately 95% of the desired
remediation activities that are in addition to its progress on the
enterprise-wide management information systems. The company has substantially
completed its assessment of the actions necessary with respect to all of its
other date-based computer systems in order to minimize Year 2000-related
disruptions. The remediation, testing and certification of such systems at each
site is substantially finished, and the completion of remaining activities,
including development of final contingency plans, is expected to occur during
the third quarter of 1999.
Through June 30, 1999, the company incurred costs of approximately $70 million
related to the implementation of its global enterprise-wide management
information systems, of which approximately $52 million was capitalized and $18
million expensed. The company estimates additional costs in 1999 of
approximately $9 million, of which approximately $2 million is expected to be
capitalized. In addition, the company estimates the total costs for conducting
its Year 2000 remedial activities not addressed by the global enterprise-wide
management information system at approximately $9 million. The company has
expended approximately $5.2 million for these activities through June 30, 1999,
including $3.2 million in the first half of 1999.
-14-
<PAGE> 15
THE LUBRIZOL CORPORATION
------------------------
Management's Discussion and Analysis of
Financial Condition and Results of Operations
---------------------------------------------
The company continues to survey suppliers critical to its business for the
purpose of obtaining assurance regarding their ability to properly operate their
systems in the Year 2000. Based on this process, the company believes its
ability to obtain critical materials will not be significantly affected by its
suppliers' Year 2000 situations. The company has also been surveying significant
customers to determine Year 2000 readiness. However, the company has no
contractual or other right to compel its suppliers or customers to be Year 2000
compliant.
The company has developed high-level contingency plans in the event any of its
critical suppliers or significant customers should incur Year 2000 failures in
their systems that would cause a disruption in the company's ability to conduct
business. More detailed contingency plans are in the process of being finalized
for each facility. Some of the areas addressed in these plans include increased
staffing, higher carrying levels of inventory for critical materials, components
and finished goods and alternate suppliers for critical raw materials. The
company's view of a "reasonably likely worst case scenario" would entail the
temporary shutdown of a production unit at one or more of the company's major
manufacturing sites. Although the company does not anticipate such a scenario
will occur, if it were to occur, the company believes it would be able to
correct the problem in a timely fashion, alternatively source the production or
satisfy the customer demand from existing inventory. If the company's
contingency plans are not adequate or its suppliers or customers fail to remedy
their own Year 2000 matters, the company's results of operations and financial
condition may be materially adversely affected.
CAUTIONARY STATEMENT FOR SAFE HARBOR PURPOSES
- ---------------------------------------------
This Management's Discussion and Analysis of Financial Condition and Results of
Operations (MD&A) contains forward-looking statements within the meaning of the
federal securities laws. As a general matter, forward-looking statements are
those focused upon future plans, objectives or performance as opposed to
historical items and include statements of anticipated events or trends and
expectations and beliefs relating to matters not historical in nature. Such
forward-looking statements are subject to uncertainties and factors relating to
the company's operations and business environment, all of which are difficult to
predict and many of which are beyond the control of the company. Such
uncertainties and factors could cause actual results of the company to differ
materially from those matters expressed in or implied by such forward-looking
statements. The company identified certain, but not necessarily all, of these
uncertainties and factors in its MD&A contained on pages 18 and 19 of its 1998
Annual Report to its shareholders, to which reference is made and which are
incorporated by reference herein.
-15-
<PAGE> 16
THE LUBRIZOL CORPORATION
------------------------
Item 3. Quantitative and Qualitative Disclosures About Market Risk
----------------------------------------------------------
The company operates manufacturing and blending facilities,
laboratories and offices around the world and utilizes fixed and
floating rate debt to finance its global operations. As a result,
the company is subject to business risks inherent in non-U.S.
activities, including political and economic uncertainty, import
and export limitations, and market risk related to changes in
interest rates and foreign currency exchange rates. The company
believes the political and economic risks related to its foreign
operations are mitigated due to the stability of the countries in
which its largest foreign operations are located.
In the normal course of business, the company uses derivative
financial instruments including interest rate swaps and foreign
currency forward exchange contracts to manage its market risks.
The company's objective in managing its exposure to changes in
interest rates is to limit the impact of such changes on earnings
and cash flow and to lower its overall borrowing costs. The
company's objective in managing its exposure to changes in foreign
currency exchange rates is to reduce the economic effect on
earnings and cash flow associated with such changes. The company's
principal currency exposures are in the major European currencies,
the Japanese yen and certain Latin American currencies. The
company does not hold derivatives for trading purposes.
A quantitative and qualitative discussion about the company's
market risk is contained on page 19 of its 1998 Annual Report to
its shareholders. There have been no material changes in the
market risks faced by the company since December 31, 1998.
PART II. OTHER INFORMATION
--------------------------
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
The Annual Meeting of Shareholders of the Corporation was held
April 26, 1999. The following matters were voted on by the
shareholders:
1. Election of directors:
(a) William G. Bares. The vote was 44,949,105 shares for
and 2,941,533 shares to withhold authority.
(b) Jerald A. Blumberg. The vote was 44,978,391 shares for
and 2,912,247 shares to withhold authority.
(c) Peggy Gordon Elliott. The vote was 44,906,908 shares
for and 2,983,730 shares to withhold authority.
(d) David H. Hoag. The vote was 44,937,957 shares for
and 2,952,681 shares to withhold authority.
(e) Daniel E. Somers. The vote was 44,977,578 shares for
and 2,913,060 shares to withhold authority.
2. A proposal to confirm the appointment of Deloitte & Touche
LLP as independent auditors. The vote was 47,464,704 shares
for; 269,099 shares against; and 156,835 shares abstaining.
-16-
<PAGE> 17
THE LUBRIZOL CORPORATION
------------------------
PART II. OTHER INFORMATION (Continued)
--------------------------------------
3. A proposal to adopt a shareholder proposal regarding The
Lubrizol Corporation Shareholder Rights Plan. The vote was
27,035,345 shares for; 12,586,394 shares against; and
1,194,341 shares abstaining. A total of 7,074,558 shares
that were represented at the meeting did not exercise any of
the options set forth above.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
(27) Financial Data Schedule
(b) Reports on Form 8-K
During the quarter ended June 30, 1999, The Lubrizol
Corporation filed a Current Report on Form 8-K dated March
31, 1999, reporting under "Item 5 - Other Events," the
settlement between The Lubrizol Corporation and Exxon
Corporation of all intellectual property litigation between
the two companies and their affiliates, except for
litigation in Canada.
Signatures
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE LUBRIZOL CORPORATION
/s/John R. Ahern
------------------------------
John R. Ahern
Chief Accounting Officer and
Duly Authorized Signatory of
The Lubrizol Corporation
Date: August 13, 1999
-17-
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